Proper asset allocation will spread your investments and your risk among broad asset categories, such as stocks, bonds, and cash. With diversification, we go one step further and look at how you might spread and position your investments within each of these categories.

An investor might allocate all of his investment dollars to stocks if he is 25 and saving for retirement, or he might put all of it in cash instruments if he is saving for a down payment on a home that he wants to buy in just a few years. But even within the category of stocks or cash, there are many kinds of investments to choose from.

Cash

Investments in cash and and cash equivalents are the safest kind of investment, and often guaranteed. Most often, you cannot end up with less than you originally invest, like a savings account. The more liquid the investment, the lower the return is likely to be. With cash investments, liquidity and fees, along with the length of your investment, are the key factors.

If a two-year certificate of deposit receives all your cash investment allotment, you will undoubtedly double the return of sinking that allotment into a regular savings account. The downside is that you cannot access certificate of deposit funds until the certificate matures, in the above case for two years, without suffering a significant penalty fee. You may have been better off in this case to keep some of your cash more liquid should you need to withdraw a portion of your cash assets. Treasury bills, money market deposit accounts and money market funds are secure investment vehicles that offer varying degrees of return. The fact is with cash investments, the easier and more rapidly you can access the funds, the less will be your return.

Bonds

A bond is simply a debt instrument – an IOU issued by a local, state or federal government or a large corporation. Bonds are like cash in that they are generally a fine way to preserve capital and they also offer a way to earn income, balance the risk of a stock investment and manage tax liabilities. When interest rates rise, bond prices fall, but your money market investment will gain value. Bond issuers can default, but this is rare for most bonds, and they are also difficult to sell off in a falling interest rate market.

The way to diversify your bond purchases is to buy bonds from different issuers and with different maturity dates. It may be difficult to have a well-diversified bond portfolio with less than $10,000, as Treasury securities are available in increments of $1,000 and corporate and municipal bonds often have a minimum of $5,000 or more. With a lesser amount you may be better off buying a bond mutual fund that offers built-in diversification.

Stocks

Over a period of years, stocks have proven to deliver the highest return of any asset category, they also provide the highest level of risk. As with baseball, you can hit a grand slam or strike out the first time you are up to bat. But for the entire season, as in baseball, or over an entire career, most stocks that hit it big will generate positive results. Because of this, stocks are the most suitable for long-term investments that are capable of riding out the storms than for short-term savings that are more liquid and can be drawn upon with impunity when needed.

Stock portfolios are generally made up of purchases across diverse business sectors – maybe financial, media, transportation and hospitality. You should be careful to choose sectors that do not tend to rise and fall on the same economic indicators. This means that automobiles and air travel, for example, will both fall with a stagnant economy as will other \”luxury\” items like restaurants and theme parks – any industry dependent upon consumers\’ discretionary income. Oddly, movies have proven to do well in sluggish economies as do essentials like food and clothing, especially the bargain varieties.

Choosing mutual funds can be wise as these avoid the peaks and valleys of individual stocks by averaging gains and losses across numerous companies and industries.

Author Bio: For more interesting articles on 403(b) rollovers, roth IRA conversions, or other financial topics, please visit Kennard Wealth Management.

Category: Finances
Keywords: cash investments,money market,bonds,diversification,diversified portfolio,finance,wealth management